Factor investing has long been a staple of quantitative equity portfolio management and has generated a great deal of interest on the Fixed Income side in recent years. With the introduction of the Axioma Factor-based Fixed Income Risk Model, estimated through cross-section regression of issuer spread returns, we can study the properties of fixed income style factors such as Momentum, Value, Size and Beta to the market. And something interesting has happened during the COVID crisis:
- Using monthly overlapping returns going back to 2002, we can estimate style factor volatility with an EWMA estimator with 1 year half-life and 4 year look-back. We compare both Fixed Income and Equity style factor volatilities computed under these settings. We use the Fixed Income covariance settings for the Equity model for ease of comparison; it should be noted that, for this reason, the equity factor volatility computed here differs from what is published in the Axioma World-Wide Equity Risk Factor Model, although the factor returns are the same.
- Throughout this history, the Beta factor for both FI and Equity generally has had the largest volatility of all the style factors. The FI Beta vol has been fairly stable since 2007, fluctuating between 5% and 7.5%, while the Equity Beta vol has been mostly between 3% and 5% except for a period starting with the Global Financial Crisis.
- Until March 2020 and COVID, that its, as can be seen in the chart. Suddenly Beta volatility shoots up. For Equity Beta vol, it’s back to GFC levels of 7%. But for FI Beta, this is something new and extraordinary, spiking up to over 19%. The other FI and Equity style factor vols also increase, most notably Size, but not to levels different from the GFC.
- The impact of the new regime in Fixed Income Beta behavior has been explored in the blogpost “Corporate Credit Portfolio Construction: Targeting low-beta names during the COVID-19 Market Crisis”.